Movements in stock markets reflect a country’s economy and its performance globally to a great extent. By tracking economic indicators the government and other agencies release, one can get an idea of where the stock market will head and help investors and analysts.
In this blog, we will learn about some economic parameters, their use and how they affect your portfolios.
What is an economic indicator?
An economic indicator is a set of statistical data collected and released by the government or other agencies. It helps in getting a clear picture of how the overall economy of a country is performing based on recently collected data. Based on this data, future estimates of economic progress gets projected. If estimates are in line with or better than expected, then it is concluded that the economy is growing.
What are the most important indicators for an investor to track?
An investor must keep a tab on economic indicators to follow investment cycles and understand where the economy is going. But the problem is that there are many indicators to do so. Hence, to simplify things, we have considered some key indicators you can track to get a fair idea of where the economy is heading.
A strong economy is often associated with a strong stock market. A portfolio heavily invested in equities of such a country may benefit from strong GDP growth since they are stakeholders in its economy.
In Indian Markets, a similar trend was seen in the past; from the year 2000, NIFTY, the benchmark index of India’s National Stock Exchange (NSE), started rising along with the rise in GDP, as can be seen in the chart below.
Some agencies that release and forecast data related to India’s GDP growth are IMF, World Bank, The National Statistical Office, etc. One can predict where markets will head by keeping track of this data.
(BOTTOMLINE: Higher GDP growth rate may lead to higher returns and vice-versa)
DATA SOURCE: WORLD BANK, NSE
Interest rates are one of the most significant economic indicators which may affect a portfolio. When interest rates rise, bond prices tend to fall, and when interest rates fall, bond prices tend to increase. For example, if an investor holds a bond with a fixed interest rate of 3% and interest rates in the market rise to 4%, the bond will be less valuable because newly issued bonds offer a higher rate of return. This can lead to a decline in the value of the bond portfolio.
On the other hand, listed stocks suffer negatively because of the rise in interest rates. Raising money from the market becomes costlier due to the rise in interest rates, and existing loans become more expensive to service and eat away companies’ profits.
RBI Key Interest Rates: (In Indian Context)
The central bank of a country decides what should be the key interest rates. The Reserve Bank of India (RBI) assumes this function in India. The RBI gives loans to commercial banks at an interest rate which is called as repo rate, and the interest rate at which RBI borrows money from commercial banks is called the reverse-repo rate. Generally, the repo rate is higher than the Reverse-Repo rate. A country’s central bank uses these key rates to manage the money flowing into its economy.
(BOTTOMLINE: Higher interest rates may lead to lower returns from stock markets, and vice-versa)
Inflation: Inflation can erode the purchasing power of cash and fixed-income investments, making stocks and other assets that have the potential to increase in value more attractive. For example, if an investor holds a portfolio of stocks and bonds and inflation rises to 4%, the purchasing power of their portfolio will decline. However, if the portfolio includes stocks in companies that can increase their prices to keep pace with inflation, the portfolio value may be affected less. On the other hand, higher than expected inflation leads to a decline in the demand for goods and services as money becomes dearer, and people tend to save instead of spending. This may lead to a fall in the prices of stocks as markets are said to be forward looking, and a fall in demand for goods and services gets reflected in the stock prices.
The government of India releases inflation data monthly in the form of Consumer Price Index (CPI) for retail consumer goods and Wholesale Price index (WPI) for wholesale markets. This data is based on the basket of goods, services and commodities traded locally and globally. RBI decides its key interest rates (Repo and Reverse-Repo) and tries to maintain inflation rates in line with the economy’s growth.
In “2022”, US Federal Reserve started raising its key interest rates to contain high inflation. This led to the fall of major US-based indices like NASDAQ and Dow Jones as borrowing funds from banks became costly.
(BOTTOMLINE: High inflation rate may lead to lower returns from stock markets)
Every major stock exchange has a benchmark index. In India, The National Stock Exchange (NSE) has a benchmark index called NIFTY 50, while the oldest stock exchange in India, BSE, has its own benchmark index called SENSEX. These benchmark indices consist of stocks that have a strong track record of performance and a high market capitalization.
The performance of these indices indicates the trend that the overall markets may follow, as most of the funds in a stock exchange tend to flow in these stocks.
(BOTTOMLINE: If the benchmark index is rising, then portfolio return from equity investments may also rise)
High unemployment can indicate a weak economy, which may negatively impact a portfolio heavily invested in equities. For example, suppose the unemployment rate of a country is high. In that case, consumer spending will likely decrease, leading to a decline in the market value of the portfolio invested in that country’s stock market.
(BOTTOMLINE: Higher unemployment rate may lead to lower returns from stock markets)
Unforeseen events such as war, natural disasters, or terrorist attacks can create uncertainty in the markets and affect the value of a portfolio. For example, in 2022, due to the Russia-Ukraine war, crude oil and natural gas prices increased, leading to higher inflation due to a rise in energy costs worldwide. This led to the fall of major indices worldwide as it was uncertain when prices would stabilise again.
Currency Exchange Rates
The change in the currency exchange rate can affect the portfolio’s value if it holds assets in foreign currency. For example, suppose an investor holds a portfolio invested in a country’s stock market whose currency has appreciated against the investor’s domestic currency. In that case, the portfolio will increase in value due to the currency’s appreciation. However, if the currency depreciates, the portfolio value will decrease.
Case study: In 2022, as the rupee started depreciating against US dollars, foreign portfolio investors began taking out their money from Indian markets, leading to a downfall in Indian stock markets.
(NOTE: Depreciating currency is not bad for all the listed stocks, specific sectors which earn a major chunk of their revenue from the export of goods and services to other countries can benefit from the depreciation of the rupee. IT, Pharma, speciality chemicals, agriculture exports, etc., are sectors which may benefit from depreciating currency)
Economic indicators provide an insight into how the future will look for a country and thus help investors decide what mix of investment products must be used to protect their interests. Hence keeping a tab on them is necessary to align and achieve your financial goals.
At WealthDesk, we help you to invest in WealthBaskets, i.e. the combinations of stocks and ETFs reflecting an idea, theme, or investment strategy, and are created by SEBI-licensed investment advisors and research analysts.
Stock markets may be used as an economic indicator as they tell about the general sentiment about an economy’s performance. Foreign investors also invest in the stock markets of other countries, and their fund inflows into a country’s stock markets show the faith that they have in the country’s growth in future. However, market performance is not an excellent indicator for judging a country’s economy.
GDP is an economic indicator which is generally used to measure an economy. It measures the monetary value of all the final goods and services produced in a country in a given period. (Usually calculated yearly or a quarter). Gross National Product (GNP), Per Capita Income, etc are other economic indicators that can measure a country’s economy.
To ensure that the data regarding economic indicators are correct, we recommend visiting the organisation’s website, which is releasing it. Various financial news websites also have a calendar where they update data of many indicators in one place. For example investing.com